Explain the role of economies of scale in oligopoly.

Question

What will be an ideal response?

Answer 1

Large economies of scale mean that a firm can produce a large quantity at a
significantly lower cost than the cost to produce a small quantity. This effect is
pronounced in heavy manufacturing industries, such as automobile and steel. Large
economies of scale also play a role in some service-based sectors. For example, big
box stores take advantage of economies of scale in procuring products and managing
inventory. Whatever the market, oligopolists benefit from a reasonably low cost of
production when producing a large fraction of the market output. This helps sustain their
market power and poses a significant barrier of entry to newcomers. The latter
necessarily operate at a smaller scale than well-established firms. The newcomers
suffer high initial costs that are typically greater than the prices set by the oligopolists for
their goods or services, leading to heavy losses for the newcomers. Thus, large
economies of scale facilitate the existence and persistence of oligopoly.